Where should I invest to hedge against the stock market going down?

Question

Let's say that the stock market falls in value for whatever reason. Maybe a bank or two goes out of business, for example, and stocks fall 20-30%.

What would you invest in if you were sure this was going to happen? Precious metals is one thing that comes to mind. What else would generally go up if confidence in the financial system fell?

Answer 1

If you believe the stock market will be down 20-30% in the next few months, sell your stock holdings, buy a protective put option for the value of the holdings that you want to keep. That would be hedging against it. Anything more is speculating that the market will fall.

Answer 2

If you were certain you would probably do best by short selling an ETF that tracked the index for the market you think was about to tank. You'd certainly make a lot more money on that strategy than precious metals.

If you were feeling super confident and want to make your money earn even more, you could also buy a bunch of put options on those same ETF funds.

Obligatory Warning: Short selling and options can be extremely risky. While most investments cap your potential losses to your total investment, a short sale has no theoretical limit to the amount of money you can lose.

Answer 3

Sometimes the simple ways are the best:

• sell your existing stock holdings
• buy bonds
• hold currencies (weak return though)
• buy commodities (gold is a crisis hedge, though subject to its own risks)

Answer 4

Put Options. They're less risky than shorting, and have similar upsides. The major difference is that if the price goes up, you're just out the underwriting price. You'll also need to know when the event will happen, or you risk being outwaited.

More traditionally, an investor would pull their money out of the market and move into Treasury bonds. Recall that when the market tanked in 2008, the price of treasuries jumped. Problem is, you can only do that trade once, and it hasn't really unwound yet. And the effect is most pronounced on short term treasuries, so you have to babysit the investment.

Because of this, I think some people have moved into commodities like gold, but there's a lot of risk there. Worst case scenario you have a lot of shiny metal you can't eat or use.